By Carrie Johnson
Washington Post Staff Writer
Thursday, September 14, 2006
Silicon Valley has long been the stuff of dreams, a place where gawky entrepreneurs create billion-dollar companies in their garages, their innovations sometimes bending the rules but forever changing the way we listen to music or chat with friends.
But lately, it seems, the valley has shifted from a shiny beacon of capitalism's promise into a shadowy target for investigators.
Last week Securities and Exchange Commission officials told Congress that they were investigating 100 companies for possibly rigging their compensation systems to guarantee lucrative payments to executives and favored employees. That figure includes many technology firms whose volatile stock prices sweetened the incentive to engage in improprieties.
Even Hewlett-Packard Co., the standard bearer for ethics among Silicon Valley's home-grown technology community, is hustling to move forward after the resignation Monday of its chairman, Patricia C. Dunn, amid investigations by prosecutors and federal lawmakers over whether directors' phone records were illegally accessed. Prompted by concerns that a board member leaked information to the press, the HP debacle is shedding light on the valley's insular culture, where secrets are prized and key players have multiple and sometimes conflicting obligations.
No industry has been immune to executive greed or governance lapses in recent years. The era's most disastrous collapses, of Enron Corp. and WorldCom Inc., occurred far from Silicon Valley. But the same mind-set that inspired so many technology entrepreneurs probably contributed to a breakdown in sound business practices, regulators said.
"You have industries where their whole thought process is to think outside the box," said Charles D. Niemeier, a former top accountant in the SEC's enforcement division who now oversees the accounting industry. "That works really well -- except when it comes to compliance with the securities laws."
A generation ago, Silicon Valley was a backwater, thousands of miles from the nation's financial center on Wall Street and serviced by a few investment banks, law firms and private investors with enough cash to fuel start-up ventures. But the technology boom of the 1990s changed everything. It drew billions of dollars west and made millionaires of young inventors and salespeople, many of whom had virtually no experience running a business.
Regulators later uncovered financial improprieties from that period, including "round-trip" deals where technology firms entered into agreements with each other to give investors the appearance that they were winning customers and gaining traction in the market. What mattered at the time was not reality, but the illusion of success, which often triggered a rise in the stock price, Niemeier said.
This year, investigators have focused anew on the technology sector and the apparently common practice of backdating stock options. A popular method of attracting employees, options give workers the chance to buy stock at a set price and within a specific time frame. Employees profit from the difference between the share price at the time of the grant and the price on the day the stock is sold. In backdating cases, executives have selected award dates after the fact that marked low points in the company's stock price, increasing the likelihood of a windfall. Backdating violates the law if it is not properly disclosed to investors and tax authorities, prosecutors and securities regulators have said.
Cnet Networks Inc., VeriSign Inc. and Macrovision Corp. are among the Silicon Valley businesses that have announced that they received subpoenas from Kevin V. Ryan, the U.S. attorney for the Northern District of California, over their options practices, according to securities filings. Apple Computer Inc. also has disclosed irregularities in its option grants.
"I don't think greed has any special place in Silicon Valley," said Bill Burnham, a former investment analyst who founded Inductive Capital L.P. in Menlo Park, Calif. "There're greedy people everywhere. . . . I've seen a lot of people take very principled stands here where a lot of money is at stake."
Yet the latest round of investigations underscores how Silicon Valley's freewheeling culture is, sometimes painfully, making way for a more mature and formal system, where companies now public are required to abide by their obligations to investors, business and legal analysts said.
"Ten years ago, a lot of these companies were private," Burnham said. "That kind of culture and ethos remains. Some people may have lost sight of, hey, you're public, you have to change the rules now."
Moreover, the rapidly growing businesses often lacked in-house accounting and legal expertise, said Matthew J. Jacobs, a former prosecutor who leads the white collar defense practice at McDermott Will & Emery LLP in Northern California. "You're dealing with young companies that . . . do not necessarily have a long tradition of corporate governance," he said, "and part of it is learning on the job."
For advice and financing, companies often turned to the same core group of professionals, including lawyer Larry W. Sonsini and investment banker Frank P. Quattrone, who guided them at the beginning of the era. Sonsini and Quattrone spent years cultivating important relationships and achieved unusual prominence in a subculture that makes celebrities out of businessmen.
After Quattrone struck a deal last month with federal prosecutors, who agreed to dismiss criminal obstruction of justice charges against him after an appeals court threw out his conviction, Silicon Valley executives warmly applauded his return. During the technology boom, Quattrone earned $100 million in a single year and spread more wealth to his friends and associates, who through a program known as "Friends of Frank" got the opportunity to buy stock at low prices before hotly anticipated public offerings.
Sonsini founded a Palo Alto law firm, Wilson Sonsini Goodrich & Rosati, and has advised numerous chief executives, shepherded such companies as Google Inc. and Netscape Communications through lucrative stock offerings, and often persuaded clients to pay their bills not in cash but by giving up even more valuable stock in their companies. Ethics experts say the practice is acceptable but can raise questions about a lawyer's incentive to protect management interests.
In a nod to its ubiquity in Silicon Valley, Sonsini's firm has advised both HP and its former board member Thomas J. Perkins, a venture capitalist who pushed the company to disclose questionable methods used by a subcontractor to monitor directors' phone calls. Sonsini, who did not employ or supervise the subcontractor, apparently contacted HP lawyers and ultimately assured Perkins that it appeared that the process was "well done and within legal limits" in a June 28 e-mail message. Yesterday a spokesman for California Attorney General Bill Lockyer told reporters that the office might bring criminal charges over the call monitoring within a week, but the spokesman declined to name targets of the probe.
The HP board again turned to Sonsini to lead a Sunday conference call to discuss the fate of Dunn, the board's chairman, even though, legal analysts said, Sonsini will be an important witness in federal and state investigations.
"Boy, this turns into a mess," said Wayne State University law professor Peter J. Henning, who co-founded a popular Internet blog on white-collar crime issues, as he contemplated Sonsini's role at HP and how it affected the issue of attorney-client privilege.
Stephen Gillers, a professor of legal ethics at New York University, said that he lacked enough information about Sonsini's role to determine whether he may have run afoul of conflict of interest rules. But Gillers said that simultaneously comforting a former board member and protecting HP's interests do not in and of themselves sound alarms. State ethics boards rarely police conflict violations and clients themselves have the power to waive conflicts, he said.